Q:  Would you tell us about the history of the Smead Value Fund? A : The Smead Value Fund was launched on January 2, 2008 as a no-load mutual fund that invests in large capitalization stocks with a value oriented investment style. Currently, the total net assets of the fund are approximately $52 million. Q:  What are the main principles that constitute your investment philosophy? A : We are contrarian buyers looking for durable businesses at the time of maximum pessimism. Our objective is to own these names through many business cycles in order to generate compounded returns that are far superior to market averages. All good businesses may fall on hard times for reasons that are beyond their control. However, as long as these companies meet our investment criteria, we will initiate our research process. In our view, wealth is created by using extremes of pessimism to enter into ownership of great companies. Companies go on sale for reasons that are transitory in nature, but they are bound to offer discount when other participants in the market are not prepared to invest. We also believe in holding our companies for the long term and we are prepared to own them through multiple business cycles. We have come to believe in letting our winners run longer and not tinkering with stocks that we own. Excessive trading and constant portfolio rebalancing is something we avoid with a passion. Q:  How do you transform this philosophy into the fund’s investment strategy? A : Since we believe in valuation, we look for businesses that will endure through volatility thanks to their potential. Our belief is that stocks purchased in the lowest quintile based on earnings, cash flow valuations and dividends produce higher-than-average returns, with the value advantage growing even more as the holding period increases. In fact, we do not invest in businesses that have much in the way of up or down cycles but rather in those that are out of favor due to temporary circumstances or fixable issues. We are looking for companies that are consistent performers on the back of durable businesses. We focus on holding durable businesses at a deep discount to their earnings capacity if they meet the other criteria on our list – strong balance sheet, high free cash flow, a long history of profitability and wider moats. Q:  Would you describe your investment process? A : We employ a set of eight criteria in our investment process. Our stock selection is basically an auditioning system in that we look for stocks that fit all these requirements. Our criteria have a tendency to guide us toward long duration businesses that are much more consistent and might make 85% of the money in 50% or 60% of the time rather than cyclical businesses that make money 15% of the time over an entire business cycle. The characteristics that our criteria address are as follows. A business has to meet certain economic needs; it must have a wide moat to make long duration investments for the next three decades; a long history of profitability, going back at least ten years, and strong operating metrics are also required; dividends high free cash flow generation are also preferable; and it is available at a low price in relation to intrinsic value. Additionally, we take into consideration a shareholder friendly business culture; substantial insider ownership and/or preferably significant insider purchases. And then lastly, we prefer strong balance sheets. We believe that at any given time in the United States there might be 200 businesses that fit those characteristics. The actual research process starts when one of the businesses has fallen on hard times, so that the stock is out of favor for one reason or another. For example, bank stocks are currently out of favor, which opens a door for us to compound our investment over next several years. In cases when a stock went nowhere for ten years or it took a big drop due to some short-term circumstances, our research process will look at the long term fundamentals to evaluate the track record over the last three decades. That backward review helps us to understand if the company has the capacity to earn over various business cycles. While we will meet with management teams if we are invited, we do not make a practice to visit companies. We assume that we get about three good new ideas available to us within a year. And when a new idea seems meritorious, we either take money out of a poor performer that we have owned for many years, concluding that our original thesis was wrong, or we trim back something that we have owned for a long time that has good fundamentals but trades at a rich price. Q:  What is your buy discipline? A : In general, we try to buy businesses that are reward investors for most of the time and not some of the time. Academic research shows that most stocks generate 85% of their return in 15% of the time they are held in a decade or a business cycle. Most investors are engaged in finding the right point of entry to own these stocks to get the most of the 85% of the gain with the shortest holding period. For example, capital intensive businesses in cyclical industries are only good at delivering returns only two of the ten years or five of the thirty years. Such companies trade at extreme valuations at their earnings peak and precisely at the time when they enter a long negative return phase. We like to avoid these sectors and these companies at such euphoric times. While we avoid those businesses that may be favored by growth or momentum investors for their immediate years of profitability, we prefer businesses that are generating profit consistently through various business cycles. For example, at present, the pharmaceutical industry is deeply out of favor based on the last ten-year period and still holds the same share in the S&P 500 index earnings in the period. At the same time mining equipment makers are enjoying a great run in the last seven years after two decades of losses or subpar earnings. Our preference is to buy businesses that are not only capable of generating consistent earnings, like pharmaceuticals makers over mining equipment makers, but are also trading at a discount of at least 50% to their normalized price-to-earnings ratio. We believe that when these consistent businesses are bought at the time of extreme pessimism and held for a longer term can generate superior returns. We also prefer to own businesses with substantial insider ownership for the long term and are adding to their holdings. Q:  Could you give some examples to substantiate your research process? A : Let me give an example of SLM Corporation, commonly known as Sallie Mae, originally the Student Loan Marketing Association. It is a publicly traded U.S. corporation whose operations are originating, servicing and collecting on student loans. In 1994-95, I knew that the cost of college was going to go up, the need to borrow money to go to college was going to rise and Sallie Mae was the facilitator. They were the company that made money from facilitating the student lending market and, thinking that would be very lucrative, we bought the stock. At the same time, we saw some significant insider buying in Sallie Mae. And then, not too long after the insider buying, a former executive of Sallie Mae fought a proxy battle to get himself voted on the board, became chairman of the board of directors and named himself as chief executive officer. Later on he started a process of trying to maximize shareholder value on the company. We allowed that stock to be our largest position in the portfolio from 1995 to 2005. It always traded at very reasonable price-to-earnings ratio with earnings and dividend growth in place. By 2005, we started trimming the position down significantly, and then in 2007 they got a private equity buyout offer at $57 a share. The $35 to $40 original buyout price we paid was $3.50 to $4, then we sold most of the stock in the $50s in between 2005 and 2007, and the last of our shares at $53. To cite another example, in 1999 we bought shares of Washington Mutual, Inc. a savings bank holding company. We did very well on the stock for a while and held it for nine years. The company raised their dividend every single quarter during the time that we owned the stock, but by mid-2008 we could see that the bad lending was underlying our thesis on the company and we sold it. Let me give another example. In 1995, we had a consumer recession in the United States and the Boeing Company was in a bad spot in their cycle in the Seattle area. Boeing is a big employer in Seattle, so whenever they went through a difficult period it was very difficult for businesses, especially retailers in the Seattle area. However, in 1995, Fred Meyer, Inc., a chain of hypermarkets, was doing $170 million worth of store building and renovation in the greater Puget Sound area. Everyone considered that expansion a very risky undertaking in the Seattle metropolitan area in the middle of a downturn for the Boeing Company. Yet, we saw that there were innumerable insider buys and fifteen different insiders made eighteen purchases, wherein Kohlberg Kravis Roberts & Co. owned 35% of the company. We found the company fit all our criteria. Five years later, Kroger bought them and we made five times our money in about less than four years between 1995 and 1999. Q:  How do you build your portfolio? A : Our portfolio is constructed one idea at a time. We maintain a concentrated portfolio of 25 to 30 stocks with 40% to 45% of the portfolio invested in our top ten holdings. The turnover in the fund has been about 14% in the last two years. Since we maintain a macro opinion in our portfolio composition we currently have no exposure to energy and basic materials. Our macro views guide us in looking for companies in sectors that are out of favor or currently suffering from extreme neglect from investors. Capital intensive businesses are enjoying above normal returns because capital has been cheapest in the last three decades. Companies in these businesses are likely to destroy value by overexpanding in the coming years. Q:  What kinds of risk do you keep on your radar and how do you contain them? A : We believe that we diversify enough to gain most of the benefits from diversification. Also, we take the risk of holding through multiple cycles and concentration risk. We do not believe in overdiversification beyond 30 names because we believe the benefits of diversification are not worth the risks of loss of concentration. We pay a lot of attention in protecting our downside risk, so the price we pay when we initiate a position is very important to us. As mentioned earlier, we are prepared to hold out positions for a long term so we are not averse to the market volatility, but we are prepared to sell our holdings if our original investment thesis is violated.